How to Buy a Second Home that Pays for Itself
Recent data from the U.S. Census Bureau shows that home sales were up more than 17% in June 2020 from the month before, and up more than 13% compared to the year prior. Those who have the means to buy a second home are wise to take on mortgage debt (or reorganize their current debt) in todayâs low interest environment.
Those who have the means to buy a second home are wise to take on mortgage debt in todayâs low interest environment.
With low 30-year mortgage rates, owning a rental property that âpays for itselfâ through monthly rental income is especially lucrative with a significantly lower mortgage payment. If youâre curious about buying a second home and renting it out, keep reading to find out about the major issues you should be aware of, the hidden costs of becoming a landlord, and more.
Important Factors When Buying a Short-Term Rental
The issues involved in buying a rental home varies dramatically depending on where you plan to purchase. After all, buying a ski lodge in an area with seasonal tourism and attractions might require different considerations than buying a home in a major metropolitan area where tourists visit all year long.
But there are some factors every potential landlord should consider regardless of location. Here are a few of the most important considerations:
- Location. Consumers rent vacation homes almost anywhere, but youâll want to make sure youâre looking at homes in an area where short-term rentals are popular and viable. You can do some basic research on AirDNA.co, a short-term rental data and analytics service, or check competing rentals in the area youâre considering.
- Property Management Fees. If you plan to use a property management company to manage your short-term rental instead of managing it yourself, you should find out how much other owners pay for management. Also, compare listing fees for your second home with a platform like Airbnb or VRBO.
- Taxes. Property taxes can be higher on second homes since you donât qualify for a homestead exemption. This means higher fixed costs each month, which could make it more difficult to cover your mortgage with rental income.
- Competition. Check whether a rental area youâre considering is full of competing rentals that are never full. You can find this information on VRBO or Airbnb by looking at various rentals and checking their booking calendars.
- Potential Rental Fees. Check rental sites to see how much you might be able to charge for your second home on a nightly, weekly, or monthly basis.
5 Steps to Rent Your Second Home
Before purchasing a second home, take time to run different scenarios using realistic numbers based on the rental market youâre targeting. From there, the following steps can guide you through preparing your property for the short-term rental market.
1. Research the Market
First, youâll want to have a general understanding of the rental market youâre entering. How much does the average short-term rental go for each night or each week? What is the average vacancy rate for rentals on an annual basis?
Research your local rental market, the average price of rentals in your area, various features offered by competing rentals, and more.
Action Item: Dig into these figures by using AirDNA.co. Just enter a zip code or town, and youâll find out the average nightly rate, occupancy rate, revenue, and more. Although some of the siteâs features require a monthly subscription, you can find out basic information about your rental market for free.
2. Know Your Numbers
You need to know an array of real numbers before renting your second home, including the following:
- Average nightly rate
- Average occupancy rate
- Fixed costs, such as your mortgage payment, taxes, and insurance for the rental
- Property management fees and costs for cleaning between tenants
- Additional fixed costs for things like trash pickup, internet access, and cable television
- Costs for marketing your space on a platform like VRBO or Airbnb, which could be a flat fee or 3% of your rental fee depending on the platform
Youâll use these numbers to figure out the average monthly operating cost for your second home, and the potential income you might be able to bring in. Without running these numbers first, you wind up in a situation where your short-term rental doesnât pay for itself, and where youâre having to supplement operating expenses every month.
Action Item: Gather every cost involved in operating your specific short-term rental, and then tally everything up with monthly and annual figures that you can plan for.
3. Buy the Right Insurance
If you plan on using your second home as a short-term rental, youâll need to buy vacation rental insurance. This type of homeowners insurance is different from the type youâd buy for your primary residence. Itâs even unique from landlord insurance coverage since you need to have insurance in place for your second home and its contents.
Some vacation rental policies let you pay per use, and they provide the benefits of homeowners insurance (like property coverage, liability, and more) plus special protection when your property is rented to a third party.
Action Item: Shop around for a homeowners insurance plan thatâs geared specifically to vacation rentals. See our top picks for the best homeowners insurance companies out there.
4. Create a Property Management Plan
If you live near your second home, you might want to manage it yourself. Thereâs nothing wrong with this option, but you should plan on receiving calls and dealing with problems at all hours of the day.
Many short-term rental owners pay a property management company to communicate with their tenants, manage each rental period, and handle any issues that pop up. Property managers can also set up cleanings between each rental and help with marketing your property.
Action Item: Create a property management plan and account for any costs. Most property managers charge 25% to 30% of the rental cost on an ongoing basis, so you canât ignore this component of owning a short-term rental.
5. Market Your Space
Make sure you appropriately market your space, which typically means paying for professional photos and creating an accurate, inviting listing on your chosen platforms. Your property manager might help you create a marketing plan for your vacation rental, but you can DIY this component of your side business if youâre tech- and media-savvy.
Action Item: Hire a photographer to take professional photos of your rental, and craft your rental description and listing.
Risks of Purchasing a Short-Term Rental
Becoming a landlord isnât for the faint of heart. Thereâs plenty that can go wrong, but here are the main risks to plan for:
- Government roadblocks. In destinations from New York City to Barcelona, government officials have been cracking down on short-term rentals and trying to limit their ability to operate. New rules could make running your business more costly, difficult, or even impossible.
- Your home could be damaged beyond repair. If you read the Airbnb message boards and other landlord forums, youâll find an endless supply of nightmare rental stories of houses getting trashed and rentals enduring thousands of dollars in damage.
- Housing market crash. If the housing market crashes again like it did in 2008, you might find you owe more than your second home is worth at a time when itâs increasingly difficult to find renters.
- Reliance on tourism. As weâve seen during the pandemic, circumstances beyond our control can bring travel and tourism to a screeching halt. Since short-term rentals typically rely on tourism to stay afloat, decreases in travel can affect the viability of your business, quickly.
- High ongoing costs and fees. Higher property taxes, property management fees, cleaning fees and maintenance costs can make operating a short-term rental costly in the long-term. If you donât account for all costs and fees involved, you might wind up losing money on your vacation home instead of having the property âpay for itselfâ.
The Bottom Line
A short-term rental can be a viable business opportunity, depending on where you want to buy and the specifics of the local rental market. But there are a lot of factors to consider before taking the leap.
Before investing hundreds of thousands of dollars, think over all of the potential costs and risks involved. Youâll want to ensure that youâve done comprehensive research and have run the numbers for every possible scenario to make an informed decision.
The post How to Buy a Second Home that Pays for Itself appeared first on Good Financial CentsÂ®.